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Deflation instead of inflation..

April 23rd, 2009 · No Comments

And potentially much more nasty…

Prices are falling in the UK, quite unprecedented. Their central bank have taken similar measures (‘quantitative easing’) which inflation hawks say will bring inflation. We’ve got a much more immediate threat.

Deflation, especially in this environment which is basically a deep balance sheet recession, can be lethal. It increases the real value of debt, which triggers further distressed asset sales, further reducing asset prices, thereby producing a vicious cycle in souring yet more debts and balance sheets.

Increasing real-debt levels and positive real interest rates also reduces spending further. The Government is dead-on with the massive amounts of money creation, it’s the only thing that can turn the tide…

A consensus has formed that the government’s massive money printing and debt-powered spending binge will soon destroy the destroy the dollar, crippling the remaining savings of anyone dumb enough not to buy “real” assets–like gold.

John Mauldin, president of Millennium Wave Advisors, thinks that’s ridiculous. He’s also author of the popular e-letter, “Thoughts from the Frontline.”

The Fed is printing money, Mauldin says, but overall credit is being destroyed. The government is desperately trying to bring back inflation, so we can lessen the real burden of our huge debts, but this will take a year or two at best.

So in the meantime, Mauldin says, ignore the gold bugs. They’ve been wrong for 25 years and they’ll keep on being wrong for the foreseeable future.

——–[End of article]——–

In fact, according to former Bush advisor and writer of the most popular Economics101 textbook Greg Mankiw, inflation is much better than deflation. We couldn’t agree more:

Which would you prefer — rising unemployment or inflation?

That is the question, posed and answered, by Harvard economics professor N. Gregory Mankiw in a recent New York Times commentary. Mankiw was an adviser to President George W. Bush.

Inflation is what the professor prefers, and the Federal Reserve can produce it, he says. Why? Because inflation would allow a negative interest rate.

Right now, the Fed is targeting zero and can’t go lower. But inflation creates the effect of lower rates.

“While nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative.”

With real interest rates at negative values, the economy would come back life, Mankiw says.

If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend,” Mankiw argues.

Mankiw urges Fed chairman Ben. S. Bernanke to make a commitment to higher inflation although Bernanke has previously been an advocate of inflation targeting. Most central banks have a legal mandate, be it price stability or employment, but usually not both.

“A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations,” according to Mankiw,

“Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy,” he says.

But there are worse things than inflation…[and] we have them today.”

Inflation, according to many other economists, is poised for an upturn because of the huge U.S. debt and the cost of servicing it, let alone paying it down.

Tags: Credit Crisis · Public Policy